Why the rise in credit card borrowing could affect your next mortgage

Credit card borrowing in the UK has risen at its strongest pace in 17 years whilst mortgage interest costs are now at their highest in 6 years. But why has this happened, and how could this affect you and your next mortgage?

The Bank of England (BoE) confirmed that annual credit card debt has risen by 13% suggesting households are taking on more debt to cover the recent increases in the cost of living during the worst rise in inflation in four decades. In retaliation to the worrying inflation numbers, the BoE increased its base rate to 1.75% and many believe it is poised to rise again next month. Average credit card rates now sit at 21.46% whilst the average two-year fixed rate mortgage is now at 4.09 per cent according to Moneyfacts.

“The most vulnerable have run out of quick fixes, which is why we continue to see considerable growth in demand for credit,” said Paul Heywood, chief data and analytics officer at Equifax UK. “They have cancelled recurring subscriptions, swapped to less expensive supermarkets, and reduced spending on clothes, food and holidays. Yet households are still struggling to make ends meet.”

What does this change in consumer behaviour mean?

Investors are already anticipating that the BoE will increase the base rate to 4% in the next 12 months in an attempt to tame inflation and whilst approvals for home purchases remained at 63,000 at July compared with 63,200 in June, is still well below the 12-month pre pandemic levels.

Andy McBride, Director at specialist contractor mortgage broker Cleerly had this to say:

“Whilst many of our clients are quite rightly focused on the increasing cost of borrowing at present, there is another hidden danger lurking. If the squeeze on cost of living continues to subdue the market, it is not inconceivable that we’ll see a reduction in house prices on the horizon. Homeowners coming to the end of products could be hit with a double whammy of increased rates along with a reduction in the value of their property moving them into another loan to value bracket, potentially, further increasing the rate on offer.”

The loan-to-value ratio explained

The loan-to-value (LTV) ratio of a mortgage is a crucial figure to mortgage lenders. It is calculated by dividing the value of your mortgage by the value of your property, and it informs the lender what proportion of the total value of a property you are looking to borrow. For example, a mortgage of £150,000 / a property value of £250,000 gives a loan to value of 60%. The loan-to-value (LTV) ratio is used as an assessment of lending risk that financial institutions and other lenders examine before approving a mortgage.

How a higher loan-to-value could affect your mortgage

Typically, loan assessments with high LTV ratios are considered higher-risk loans. Therefore, if the mortgage is approved, the loan has a higher interest rate. If the value of your property dips while you are living in it and you need to remortgage, you may be faced with a higher LTV, which in turn could affect your interest rate. So as interest rates rise and property values fall, you could be faced with a more expensive mortgage in future.

What should contractors do now?

Steve Clements, Senior Mortgage Consultant at Cleerly gave this advice – “Now, more than ever, my advice would be to act now and engage with your mortgage broker as soon as possible. Regardless of when you current product ends, your mortgage consultant will be able to review your situation and put together a plan around when and how to start looking at new mortgage offerings.”

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